Category: Balance Sheet ಆಯವ್ಯಯ ಪತ್ರ

In the last blog, we understood the utility of ratios in analyzing the financial status of the company. From today over the next few blogs, we would understand some of the various financial ratios better. In today’s blog we deal about current ratio.

If we look at this ration, we understand that it deals which how the current (what is at immediate disposal – if we can take it in that sense) assets could be used to handle the current liabilities. It measures the firm’s ability to repay the immediate liabilities (say the bills and notes) using the assets (say cash) that is immediately available.

It is always good to be able to pay off the liabilities that we need to pay at the earliest hence this ratio would be greater than one – clearly, the numerator has to be greater than the denominator or the assets have to be more than the liability.

If this ratio is less than 1, it is an indication of a possible cash crunch! The liability to be paid off is more than the cash that is currently available with the company.

Read in Kannada:
http://somanagement.blogspot.com/2011/07/blog-post_1733.html

In the past few blogs we looked at how an investor would look at the balance sheet and make his/her assessment about the company’s health. In the next few blogs we will look at the aspect of ratio bases analysis of the balance sheet. In today’s blog we look at the need for such ration analysis.

These various ratios are called by the name of accounting ratios, and provide a relation between the various accounting figures. Given a balance sheet, using the actual values in it to assess to assess if the company would be inappropriate; the relative values of one with respect to another section would be a better mode to make a comparison. Making it a ratio enables comparison of the various figures.

The advantages of Ratio Analysis are;

• It assists the management in knowing the earning capacity of the business.
• Helps assess the solvency of the company
• Assists comparison across years
• Simplifies the accounting information
• Calculation of the operating efficiency
• Helps forecasting

This however has certain limitations:

• Given the difference in accounting policies that the firms use, it cannot be used to compare across firms.
• Unless the absolute numbers are known, it is hard to really understand the results.

Read in Kannada:
http://somanagement.blogspot.com/2011/07/blog-post_2770.html

In the earlier blog, we looked at the Non-current assets portion of the company. In today’s blog, we look at the Liability section of the balance sheet.

One could classify the Liabilities section as current and non-current liabilities. Current Liabilities refers to the obligations the company has to pay off within the current year, these could include the payments to be done to suppliers, vendors etc. The non-current liabilities would represent those that it owes within duration more than a year. Generally this non-current section includes the bank and bondholder debt here.

A manageable debt is a good sign; if the debt is decreasing it is healthy sign. The rising debts are a cause of some worry for the investor. What is a good balance of debt would depend on the assets that it possesses, and the cash flow of the company.

Having too much debt, relative to the company’s cash flow would mean it would pay a high amount of its revenue as interest and debt repayment. If the liability is not properly managed it could get the company Bankrupt.

Read in Kannada:
http://somanagement.blogspot.com/2011/07/blog-post_5564.html

In the earlier blog, we had looked at the receivables section. In today’s section we will look at the Non-current aspects of the balance sheet – the property, plant and equipment section.

Non-current assets generally include the fixed assets; these assets cannot be liquidated within an accounting period and hence they are considered non-current. Investment into these non-current assets wouldn’t exactly be a measure of the company strength, but it’s the utility of these fixed assets like – plant, machinery etc that actually enables the production of current assets. So investors really don’t pay much attention to this section except when there is a huge capital investment into the new plant or something where in the there is a potential for long term gains.

One place where people can really lose faith in the Balance sheet is due to the way the company’s would handle these non-current assets. Since these assets cannot be sold in a reasonable period of time, and are carried on the balance sheet at cost regardless of the actual value – so the company can grossly inflate the numbers. This makes an investor question about its.

Read in Kannada:
http://somanagement.blogspot.com/2011/07/blog-post_2921.html

In the earlier blog, we had a look at the inventory and its implications from the investor’s perspective. In today’s blog we look at what the Receivable could mean to the investor.

Receivable as defined would mean outstanding (uncollected) bills. If a company sells a product and delays collecting the payment for it, it sure has to be foolishness. While giving a period of credit is a business norm today, it would be foolish to give a lot of credit and not collect them. The speed at which the company collects the amount owed to it tells us a lot about its financial efficiency.

If the collection period has been increasing it is an indication of the impending problem for the company. The larger the credit period that would be given to the customers, the higher the exposure would be to a potential threat of a not recovery of the amount. The company’s customer might face a cash crunch and decline repaying the amount. The collection period would also affect the internal working of the organization in that it could make it hard for the company to pay the salaries, buy necessary goods, etc that might be very essential.

Here too it highlights the importance of cash being very liquid and its criticality to the business.

Read in Kannada:
http://somanagement.blogspot.com/2011/07/blog-post_29.html

In the earlier blog, we looked at how an investor would look at the cash available in the balance sheet of a company and form an opinion. In today’s blog we would look at the inventory heading.

Inventories are finished goods that haven’t yet been sold. An investor would be watchful to see if a lot of the company’s money is tied up in its inventory. While inventory gives a cushion against any industrial relations problem to a certain extent, or could act as a part of the company’s prize war with another company; the investor would look as from an angle that says the money is locked up in inventory.

Companies have very little money to invest in inventory, if a lot of inventory is being piled up, and sales are low, it indicates that the company is building up for serious trouble. The longer it takes to make a sale, the longer the inventory would be with the company hence locking up the capital (money) flow. The issue might grow up to such an extent that the company might find it hard to pay off its suppliers in time!

How many iterations the inventory would take up within a year is measured by “inventory turnover”. This is measured as the total cost of goods sold divided by the average inventory. The Inventory Turnover measures how quickly the company is moving merchandise through warehouse to customers. If inventory grows faster than sale, it is almost always an indication of a fundamental mismatch.

Read in Kannada:

In the earlier blog, we had a brief explanation of what the various heads in the Balance sheet meant. We would keep explaining some of the additional heads as we progress with the blogs.

As a manager it is important to understand the way an investor would look at the various components on the balance sheet. So we begin understanding this over the next few blogs.

In business “cash is king” – it the most liquid format of assets and can be easily converted for a variety of purposes. A good reserve of cash shown in the Balance sheet would attract a lot of the investors towards such a company. They would believe cash would offer some protection against the sluggish times that are common in the economic cycles; also, the extra cash could be used for exploring new options for growth.

A company that is performing consistently would generally have a healthy cash reserve, this is an indication that the company has been performing well – The management is short of time to really utilize the accumulating money! The opposite of cash in surplus, i.e. if the cash is found to fast dwindling then this is sign of serious trouble.

If the cash accumulation over a long period is not used up for productive purposes, the question of the effectiveness of management could also arise. The reason management has allowed such accumlation, could be lack of good investment opportunities.

Read in Kannada:

In the earlier blog, we put up a rough structure to the various components in a balance sheet, but we haven’t explained the various headings. While it is pretty logical to understand these from common parlance, explaining them here would add to the context.

• Cash – the cash is the revenue that is earned by the company
• Receivables – are outstanding (uncollected bills) amount to be collected from the customers
• Inventory – these are finished goods that have not yet been sold
• Fixed Assets – includes the investment of money into plant and machinery
• Account Payable – the payment to be done to suppliers etc
• Notes Payable – some of the promissory notes (like cheques etc) that are to be paid up
• Long Term Debt – Long term loan that might have been taken from banks, and have been invested in the business
• Owner’s Equity – this includes the initial capital generated by the promoters, (share holder also later on)

Read in Kannada:
http://somanagement.blogspot.com/2011/07/blog-post_3720.html

In the earlier blog we looked at the current assets and current liabilities, we now take another look at the other components in the Balance sheet.

In the last blog we also got to know the reason why these are called – current (assets or liability), so one could safely assume that the ones that do not fall into this category would generally be of a longer time frame in nature. What would these be?

If we look at the assets side of the Balance sheet, we realize that the ones that do not get converted in a year’s cycle should generally – of the nature of buildings, furniture, machinery etc. These are called the Fixed Assets.

On the liability side, the ones which of long term nature could further be looked at as two components – A debt which is long term (would take a long time to clear off) or could be the equity that is put in by the owner. Thus we would generally have two sub-components – Long term Liabilities and Owner’s Equity.

We could represent the balance sheet in the following manner.

Read in Kannada: